Emerging-Market Shakeout Putting Reserves Into Focus: Currencies

Pedestrians stop and look at foreign currency exchange rates on an electronic board at an exchange office in Istanbul. Turkey spent 27 percent of its foreign reserves trying and failing to defend its currency since June, leaving it with $34 billion as of Feb. 10, excluding commercial banks’ deposits. Photographer: Kerim Okten/Bloomberg

Feb. 12 (Bloomberg) -- Foreign-exchange reserves are
emerging as the latest battleground between traders and
developing nations trying to stem the worst rout in their
currencies since 2008.

Nations with the smallest reserves to fend off currency
speculators will continue to see their exchange rates under
pressure, options prices show. Of the 31 major currencies
tracked by Bloomberg, traders are most bearish on Argentina’s
peso, Turkey’s lira, Hungary’s forint, Indonesia’s rupiah and
South Africa’s rand, while the forwards market signals that
Ukraine’s hryvnia will fall 20 percent in a year.

“If you start to burn too quickly through your foreign
reserves, it’s an ominous sign -- and of course in the forex
market, they smell blood,” Robbert Van Batenburg, the director
of market strategy at broker Newedge Group SA in New York, said
Feb. 5 by phone. “It creates this domino effect.”

From Argentina to Turkey, emerging markets are under siege
as the U.S. Federal Reserve pares its record stimulus measures
and reports showing a slowdown in Chinese manufacturing raise
concerns about the strength of their economies. A Bloomberg
index tracking 20 exchange rates has fallen 2 percent this year,
building upon the 7 percent decline in 2013.

Shrinking Stockpiles

Turkey spent 27 percent of its foreign reserves trying and
failing to defend its currency since June, leaving it with $34
billion as of Feb. 10, excluding commercial banks’ deposits.
That’s only enough to cover 0.29 percent of short-term debt, the
least among 14 developing nations tracked by Goldman Sachs Group
Inc. South Africa’s $46 billion amounts to 13 percent of gross
domestic product, less than the 18 percent it needs to finance
its trade deficit and debt, according to the U.S. bank.

The lira fell to a record 2.39 per dollar and the rand
tumbled to a more than five-year low of 11.3909 last month.

“Burning through their reserves, that’s not sustainable,”
Viktor Szabo, a money manager in London at Aberdeen Asset
Management Ltd., which oversees $10 billion, said by phone on
Feb. 6. “People will be more than happy to short your
currencies,” he said, referring to a strategy of betting
against an asset. “The pressure was there and there’ll be more
pressure.”

Tenge Devaluation

Kazakhstan’s central bank devalued the tenge by the most
since 2009 yesterday after its international reserves dropped to
about the lowest since 2009, while Argentina spent $25 billion
since March 2011 defending the peso, driving the stockpile to a
seven-year low. The peso has still weakened 16 percent in 2014.

“Foreign-exchange reserves can be thought of as a shock
absorber at times of volatility, allowing EM central banks to
buffer their currencies against sharp declines by supplying U.S.
dollars to the market,” Goldman Sachs analysts Robin Brooks and
Julian Richers wrote in a Jan. 29 report. “Countries with low
reserve cover are relatively more vulnerable.”

Both Turkey and South Africa resorted to raising interest
rates last month to deter speculators, which Citigroup Inc.
warns may trigger a “vicious circle” of slower growth.

Turkey’s central bank increased its benchmark rates to as
high as 12 percent at an emergency meeting on Jan. 28, prompting
a rally in the lira of more than 4 percent.

South African policy makers unexpectedly raised rates by a
half-point to 5.5 percent on Jan. 29, a day before the rand fell
to its low. Since then, the currency has rallied 2.8 percent,
the best performance among 31 major currencies after the lira
and Australian dollar.

‘Currency Crisis’

“I wouldn’t be short exclusively on the basis that they
have little reserves,” Ilan Solot, a strategist in London at
Brown Brothers Harriman & Co., said in a Feb. 4 phone interview.
‘If they don’t start getting their act together, and if reserves
continue to be depleted, then we’re rapidly approaching a
currency crisis. That thought is unsettling.’’

Across the developing world, borrowing costs still aren’t
high enough to protect the “weakest links” among emerging
currencies, Citigroup strategists led by London-based Jeremy
Hale wrote in a Feb. 6 client note.

“Vulnerable EMs face the risk of falling into a vicious
circle,” the strategists wrote. “Weaker growth and higher
rates could weigh on local asset markets” and “if this then
leads to unwinds, capital outflows could lead to renewed
currency weakness, which would require higher rates once
again.”

Mobius, Blankfein

Mark Mobius of Templeton Emerging Markets Group says the
exodus from developing nations is “almost over,” while Goldman
Sachs Group Inc. Chief Executive Officer Lloyd C. Blankfein
argues that these economies are in better shape than during the
Asian crisis of the late 1990s. The experience of South Africa
and Turkey suggests that not all developing currencies will
share in any rebound.

Mobius, whose firm manages $50 billion in developing-nation
assets, told Bloomberg Radio yesterday that we’re “nearing the
end of this big rush out of” emerging markets.

Blankfein said in a Bloomberg Television interview
yesterday that developing economies have “better reserves, more
flexibility in exchange rates, better policy” than during the
1998 Asian crisis, when South Korea and Thailand spent billions
trying to defend exchange-rate pegs, only to eventually devalue
and seek International Monetary Fund bailouts.

Traders are paying a 6.99 percentage-point premium for
three-month options to sell the Argentine peso over contracts to
buy, the most since September 2012, risk-reversal rates show.

Higher Premiums

While the premiums for the lira, rand and rupiah have
declined from recent highs, they’re still above the average
across emerging markets and higher than levels at the end of
October. The gauge for the lira was at 4.04 percentage points,
compared with 2.78 on Oct. 31, while the gap for the rand was at
3.39, from 2.94. The rupiah’s rate was 3.91 percentage points,
from 3.61, data compiled by Bloomberg show.

Ukrainian policy makers let the hryvnia plunge to a five-year closing low of 8.855 per dollar on Feb. 6 after spending 54
percent of its reserves since April 2011 to keep the currency
steady. The reserves declined to an eight-year low of $18
billion in January, from $38 billion in April 2011.

Non-deliverable 12-month forwards for the hryvnia traded at
10.405 per dollar yesterday, implying a 17 percent decline in
the currency, according to data compiled by Bloomberg.

In Indonesia, policy makers have given up on using reserves
as the main tool for defending the rupiah after spending $20
billion in the seven months through July and still failing to
stem the currency’s slide. Instead, officials have reduced fuel
subsidies to cut the budget deficit and raised interest rates.
The rupiah gained 0.7 percent this year to 12,085 per dollar.

“Everyone is looking to bring rates higher,” Simon
Quijano-Evans, the head of emerging-market research at
Commerzbank AG in London, said in a Feb. 5 phone interview.
“It’s the first step in calming the situation. You cannot
continue using foreign reserves if no one believes in your
policy.”